Treasury sell-off reignites question: how high can yields go?

It is the question that has gripped investors as the US election looms and coronavirus cases have surged: just how far can Treasury prices fall after a momentous rally this year?

Money managers have been left grappling with that issue once more after the 10-year Treasury was hit with its biggest bout of selling in three weeks on Thursday and the yield on the benchmark sovereign bond hurtled back towards a four-month high. The decline put a months-long sell-off in US government bond prices back in motion, interrupting a mini-rally in Treasuries this week that had been sparked by the worsening pandemic.

At 0.82 per cent on Friday morning, the yield on the 10-year note is once again near the top-end of the range in which it has traded since late March, having risen 0.14 percentage points this month. The move on Thursday was enough to kick Treasury volatility to its highest level since June, according to Ice Data Services.

The shift out of Treasuries in recent weeks has been fuelled by the rising prospect of a so-called “blue wave” at next week’s US election, a scenario where the Democratic party wins the presidency and both houses of Congress. Some investors have placed bets that the bigger fiscal stimulus expected under a Biden administration would mean a stronger recovery, pushing up inflation expectations — and forcing bond yields higher.

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“The market has had a pretty big sell-off, and it could go further, but I think it will be misguided,” said Robert Tipp, chief investment strategist at PGIM Fixed Income. “In 12 to 24 months, we will still be working to revive the economy, not [dealing with] an overheating.”

According to modelling conducted by Gregory Daco at Oxford Economics, a Biden stimulus package could help fuel a roughly 5 per cent inflation-adjusted expansion in the US economy next year. A continuation of the status quo in Washington would see real GDP rise 3.7 per cent in 2021, while a Republican sweep would deliver growth of about 2 per cent.

Dan Ivascyn, group chief investment officer at investment firm Pimco, which manages $2tn in assets, says the 10-year yield could top out at 1.25 per cent — still some way below the 1.9 per cent level where it started the year.

“Any type of contested election scenario or a material deterioration in virus containment, and a resulting further shutdown of segments of the global economy, can absolutely lead to a meaningful rally in Treasury bonds,” he said.

Any sharp climb in yields would crash up against the Federal Reserve, fund managers say. Having taken unprecedented action this year to stave off a much more pronounced financial crisis, the central bank is unlikely to tolerate a destabilising rise in corporate borrowing costs.

“I don’t think we have to fear a bear market in [US government] bonds that gets out of hand,” said Alessio de Longis, a senior portfolio manager at Invesco. “The role of the Fed and the amount of support for the bond market that is coming from quantitative easing is very, very powerful.”

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